Financial Sabotage: How BATS was Brought Down

Yahoo! News: BATS Global Markets: The 'spectacularly botched' IPO:

Friday was supposed to be a coming-out party for BATS Global Markets, the flashy new stock exchange that recently became the country's third-largest trading platform behind the New York Stock Exchange (NYSE) and Nasdaq. BATS was scheduled to launch a lucrative IPO that would cement its status as one of the market's big boys. One computer glitch later, BATS' share price plummeted to a few pennies, and the company's IPO lay in ruins.

BATS (Better Alternative Trading System) Global Markets is based in Lenexa, KS, with offices in New York and London. Unlike their old-school competitors who still use trade floors, BATS executes all trades electronically.

Last Friday, BATS learned the limitations of a lightning-fast, highly-integrated computerized stock market. While the Yahoo! News story linked above places the blame on a "computer glitch" the truth may be that BATS was sabotaged by one of their competitors.

zerohedge: SkyNet Wars: How A Nasdaq Algo Destroyed BATS:

What happened is that a malicious, 100% intentional Nasdaq algorithm purposefully brought BATS stock to a price of 0.00 within 900 millisecond of the company's break for trading! This is open SkyNet warfare. 

The fact that the BATS exchange itself halted just prior to break only facilitated this (and could potentially be a case of malicious sabotage). But one thing is clear - as the data below shows, there is no doubt that an Intermarket Sweep Order originating on the Nasdaq exchange was unleashed to make a mockery out of BATS. It succeeded, and in doing so may have destroyed not only BATS chances for going public, but ultimately ruined the firm's credibility. Who would stand to gain from this? Why exchanges such as Nasdaq and NYSE of course, which already are scrambling for revenue, and in the aftermath of the failed Deutsche Boerse merger, it means that any dirty trick in the book to extend and pretend is now fair game. Such as the algo that crashed BATS.

To understand how a rogue trading algorithm destroyed the BATS IPO in less than one second, you first have to understand that an equity's price is driven in part by bids to buy/sell that equity and the incredibly fast withdrawal of those bids. That's what's illustrated in the graph above. Both the blue and pink lines illustrate how the price of BATS was walked off a cliff in nine tenths of a second. The blue line is on a logarithmic scale making the pattern a little easier to see. The data behind that chart is in the excel spreadsheet below.

From the graph above it looks like every 25ms or so the NASDAQ initiated algorithm would cancel its pending bids for BATS and issue another bevy of bids at a lower price. Because the market maker is a computer which thinks that their's significant demand for the equity at one price it, apparently, is easily enticed to think that that demand has simply moved to a lower price. At that point the equity's quote price falls and the process of ratcheting the price down further repeats.

The use of many simultaneous trades is sometimes called HFT (High-Frequency Trading).

Nanex has more about this problem in an article titled: HFT is Insatiable - its Hidden Costs:

We have spent the last 24 years working with real-time market data on a tick-by-tick basis. We monitor our commercial datafeed in real-time to stay on top of market changes or issues. This past year, we have spent considerable time and effort studying the relentless growth of equity quotes. Based on our findings, virtually all of the additional quotes contribute zero or negative economic value to stock pricing, because they are either way outside the market or end up expiring before any investor or trader could possibly act on them. Furthermore, we can't find any self-limiting mechanism in place that will ever put a stop to this unnecessary and expensive growth of misinformation. The only thing that prevents a sudden explosion in quote traffic is the capacity limitation set by SIAC which runs the Consolidated Quote System (CQS) for the exchanges.

Nanex has also has "a proposal for improving the market for everyone" which opens with this executive summary

In 2011, exchange fees for CQS were approximately $500 million. Per Reg NMS, exchange fees are apportioned to each exchange depending on how often an exchange's quote is at the NBBO. Reg NMS also describes quotes that change more than once per second as flickering quotes. Per Reg NMS, flickering quotes are ineligible to set the NBBO, and exchanges are free to ignore them for the purpose of trade-through protection. We believe that by formally recognizing flickering quotes for what they are, most of the latency games will disappear. 

Therefore we propose to:

• Set the quote condition for flickering quotes to a new condition called Immediate. Traders that want to enter a quote that can be canceled in less than 1 second, simply need to indicate this by marking the quote with the Immediate condition.
• Require regular and auto-exec quotes to remain active (and not canceled) until executed or 1 second elapses. These quotes remain eligible to set the NBBO.
• Require the time stamp field in all quote messages to be set to the time the quote was created at each exchange, instead of when it is transmitted by the network processors (SIP). This will allow all downstream users to accurately compute the age of each quote.

These simple changes will provide an incentive for exchanges to attract liquidity providers who are willing to leave their quote in the system for at least one second, because only those quotes are eligible to set the NBBO which determines the percentage of exchange fee revenue. Also, this proposal will give higher visibility to orders from investors who truly wish to buy or sell a stock. And finally, the changes to the time stamp will allow all participants to determine the age of each quote, and therefore any delays in the system.

That seems like a reasonable first step because, as it stands right now, the stock market really isn't a safe place to be if some rogue trader with an algorithm can flash crash a stock in less than a second.

Related articles

• Presenting The "Rise Of The HFT Machine" - Visual Confirmation How SkyNet Broke The Stock Market On US Downgrade Day (zerohedge.com)
• Decoding the Automatic Market (fool.com)
• Chart of the day, flash-crash edition (blogs.reuters.com)
• Catching The "Silver Crusher" Algorithm In The Act (zerohedge.com)
• BATS board backs CEO, will seek new chairman (seattlepi.com)

Market Failure by Regulation

Steve Connor in the NZHerald.co.nz reports on a bit of American regulation that is destroying the market for helium:

It is the second-lightest element in the Universe, has the lowest boiling-point of any gas and is commonly used through the world to inflate party balloons.

But helium is also a non-renewable resource and the world's reserves of the precious gas are about to run out, a shortage that is likely to have far-reaching repercussions.

Scientists have warned that the world's most commonly used inert gas is being depleted at an astonishing rate because of a law passed in the United States in 1996 which has effectively made helium too cheap to recycle.

We're all familiar with helium balloons; however, this noble gas has less frivolous applications in medicine and science. For instance, it's used to cool MRI machines. The reason that helium has become scarce is government regulation:

"In 1996, the US Congress decided to sell off the strategic reserve and the consequence was that the market was swelled with cheap helium because its price was not determined by the market. The motivation was to sell it all by 2015," Professor Richardson said.

But this is not the only regulation induced market failure in the news today. The Wall Street Journal's Dennis Berman examines the regulatory underpinnings of the recent stock market:

The May 6 "flash crash" was the culmination of 35 years of relentless stock-market reform, much of it rightly making the markets cheaper and faster, largely free from the 20th-century market makers who feasted on huge trading spreads and occasional chicanery.

Yet somehow we have wound up right where we began: with a market that many perceive as tainted and prone to gaming by a cadre of insiders. Only this time, instead of wielding the biggest, baddest berth on the New York Stock Exchange floor, they are wielding the biggest, baddest computers.

When BlackRock Inc. surveyed 380 financial advisers earlier this summer about the flash crash, their perceptions said it all: The mayhem had been primarily caused by an "overreliance on computer systems and some types of high frequency trading" strategies that roam the market en masse, looking to pick off pennies of profit.

...

Behind these changes, beginning in 1975, was a zeal to liberate the individual investor from the clutches of the archaic market makers who made a good living taking "eighths"—12.5 cents—for every share bought and sold.

The government later found Nasdaq dealers were even more gluttonous than first imagined. And by the time the last big market reforms were issued in 2005, the intent was to "give investors, particularly retail investors, greater confidence that they will be treated fairly," the SEC said at the time.

As spreads squeezed from eighths to pennies, a new batch of electronic-trading networks blinked into action. Volume trading was the only way to make money.

US Financial Earthquake causes Asian Tsunami

ABC Radio Australia reports Turmoil on Asian markets over Greek debt crisis:

Japan's central bank says it will inject more than $US20 billion in liquidity into financial markets amid market turmoil caused by the Greek debt crisis.

While the Japanese blame the Greek debt crisis, America's ABC News is investigating a Possible Trading Error:

The sources told ABC News that the possible error by Citi involved what was supposed to be a $16 million trade on an S&P 500 futures-linked contract. The trade was entered in billions instead, they said.